Strattec Security Corp: Form 10-Q for the period ended Dec 29, 2024

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis should be read in conjunction with STRATTEC SECURITY CORPORATION’s accompanying Condensed Consolidated Financial Statements and Notes thereto and its Annual Report. Unless otherwise indicated, all references to quarters and years refer to fiscal quarters and fiscal years.

Business Overview

With a history spanning over 110 years, STRATTEC has consistently been at the forefront of innovation in vehicle security, transitioning from mechanical to integrated electro-mechanical systems. Our largest customers are three leading automotive OEMs in North America, but we also provide products to other OEMs around the world. Our offering is comprised of products primarily related to vehicle power access, security and authorization and select user interface controls. Vehicle and power access solutions include power sliding doors, tailgates and lift gate systems, as well as power deck lid systems. We also design and manufacture highly-engineered latches and door handles. Security and authorization products are comprised of mechanical and electronically enhanced locks and keys, fobs, passive entry passive start systems, steering column and instrument panel ignition lock housings and related solutions. We established our leading market position within North American automotive customers initially with our legacy mechanical locks and keys. We built upon that reputation with our engineering expertise in security and vehicle access, our flexible and responsive service and our deep relationships with our customers.

Current Business Update

In conjunction with a change in leadership in 2024, we are in the process of developing a strategy to strengthen the Company’s profitability and deliver sustainable sales growth. We expect to improve our business with upgraded systems and processes and a focus on productivity and efficiencies in our manufacturing operations. We are reviewing our product portfolio, focusing on improving our working capital velocity and standardizing/modernizing our support functions. We believe this optimized cost structure will allow us to capitalize on our technical engineering expertise, market leading positions and strong customer relationships to generate innovative solutions and predictable sales growth with new and existing customers.

Volatility in the North American automotive industry is driven by supply chain disruptions, global inflation, thinning labor availability, rising global commodity costs and a changing geopolitical climate. These macro conditions, coupled with changes in production volumes by OEMs in response to new vehicle consumer demand impact our sales levels. It is expected that the North American automotive industry will grow modestly over the next several years. Despite short term softening of North American light vehicle production, we have delivered 6% sales growth over the first six months of fiscal 2025 as a result of new program launches and increased volumes on the platforms we serve. Although supply chain conditions have steadily improved and certain inflationary pressures have moderated, in the current year we continue to see material cost increases for certain commodities and electronics and higher logistics costs. In addition, a majority of our operations are in Mexico and therefore our financial results are impacted by labor inflation (government mandated increase in minimum wages) and we have exposure to changes in foreign currency exchange rates. We strive to mitigate the impact of these cost increases through supply chain and manufacturing efficiencies, strategic pricing and peso forward contracts. During the balance of fiscal 2025, we are focused on executing various initiatives to improve our cost structure, driving cash flow through improved asset and working capital utilization and securing new platforms to solidify future sales growth.

Analysis of Results of Operations

Three months ended December 29, 2024 (second quarter fiscal 2025) compared with the three months ended December 31, 2023 (second quarter fiscal 2024)

Second quarter fiscal 2025 net sales were $129.9 million, an increase of $11.4 million (9.6%) compared to the prior year second quarter. Net sales growth was broad based across most of our product portfolio and was driven by net new program launches ($6.0 million) and favorable mix. In addition, net sales on existing platforms increased $7.3 million as a result of customers building inventory levels, the prior year second quarter reflecting increased customer plant shutdowns and slightly higher production volumes. These volume increases more than offset a year-over-year reduction in pricing. The reduction in pricing is a result of the prior year second quarter including $3.9 million of one-time retroactive pricing recoveries, which was partially offset by current quarter margin accretive pricing of $0.6 million. Net sales to our customers in the second quarter were as follows (in millions):

Meaningful drivers of the change in net sales for key customers are as follows:

• General Motors Company net sales increased 9% due to increased demand across all product categories driven by production volumes for full size SUVs and trucks, as well as the launch of a door handle program for the Equinox platform.
• Ford Motor Company net sales grew 18% due to increased volume of key & lockset products and new power end gate and latch product launches on F-Series and Super Duty trucks.
• Stellantis net sales declined 11% a result of reduced demand for key & lockset products in response to dealer inventory levels and customer demand, partially offset by increased sales for power access solutions for the Chrysler Pacifica minivan.
• Hyundai Motor Group net sales increased 21% due to higher demand for power access solutions (on the Kia Carnival platform) to meet an increase in vehicle production builds.
• Net sales to all other customers increased due to new product programs and increased volume.

Second quarter fiscal 2025 gross profit was $17.2 million, compared to $13.5 million in the comparable prior year period. Despite favorable one-time pricing recoveries, net of supplier pass through requirements in the prior year, gross profit margin improved year-over-year from 11.4% to 13.2% as a result of the strengthening of the US dollar and improved leverage of our fixed cost structure on higher sales volumes.

Material costs increased $6.9 million year-over-year on higher production levels and $0.7 million of additional costs associated with excess and obsolete inventory. Labor and overhead costs increased $0.9 million year-over-year, the net result of higher conversion costs, partially offset by a $3.5 million benefit from changes in foreign currency exchange rates associated with our Mexican operations. Incremental conversion costs were driven by higher sales volumes, a $1.4 million increase in government mandated Mexico labor costs and provisions for annual bonus expense of $0.6 million (no provision in the prior year), offset by an $0.8 million reduction in depreciation expense.

Engineering, selling and administrative expenses were $15.0 million in the second quarter of fiscal 2025, compared to $13.4 million in the prior year period. Increased expenses are associated with continued investments in the business, including business transformation costs of $0.2 million, $0.3 million of incremental equity compensation expense, an annual bonus provision of $0.8 million (no provision in the prior year) and a $0.3 million restructuring charge associated with the elimination of the third shift of our Milwaukee operations. These cost increases were partially offset by lower third party engineering spend of $0.8 million based on the timing of development projects. Both the current year and prior year second quarter include non-recurring executive transition costs of $1.2 million and $1.0 million, respectively.

Interest expense relates to outstanding borrowings under our joint venture credit facility and increased to $0.3 million in the second quarter from $0.2 million in the prior year due to increased interest rates.

Investment income increased to $0.4 million in the second quarter from $0.1 million in the prior year reflecting increased levels of cash and cash equivalents, which are invested in overnight money market funds.

Other expense, net was $0.5 million in the second quarter compared to other income, net of $1.1 million in the prior year. The change was primarily due to changes in foreign currency exchange rates and gains or losses on peso forward contracts.

The effective income tax rate was 22.5% and 25.3% for the second quarter of fiscal 2025 and 2024, respectively. The effective tax rate for both periods exceeds the U.S. federal statutory rate primarily because of the foreign rate differential, state income taxes, limitations on the utilization of foreign tax credits, non-deductible items and discrete items.

Six months ended December 29, 2024 compared with the six months ended December 31, 2023

Net sales in the first half of fiscal 2025 were $269.0 million, an increase of $15.1 million (5.9%) compared to the prior year period. Net sales growth was driven by $15.4 million of net new program launches as well as favorable mix. Additionally, higher production volumes on existing platforms and customer inventory builds increased sales by $6.1 million. Sales increases more than offset a year-over-year reduction in pricing. The reduction in pricing is a result of the prior year period including $9.5 million of one-time retroactive pricing recoveries, which was partially offset by current year margin accretive pricing. Net sales to our customers in the first half of fiscal 2025 were as follows (in millions):

Meaningful drivers of the change in net sales for key customers are as follows:

• General Motors Company net sales increased 6% primarily due to overall volume increases for full size SUVs and pickups as well as new door handle volume for the Equinox EV, which impact was partially offset by several lockset programs ending.
• Ford Motor Company net sales grew 19% mostly due to increased volumes and new tailgate and power end gate content on the Ford F-Series and Super Duty trucks.
• Stellantis net sales declined 40% due to the combination of lower vehicle production volumes for several programs we supply, the end of several passenger car programs and reduced content on the Dodge Ram pickup.
• Hyundai Motor Group net sales increased 44% due to higher demand for power door products and an increase in inventory builds.
• Net sales to all other customers increased due to new product programs and increased volume.

Gross profit was $36.1 million in the first half of fiscal 2025, compared to $32.2 million in the comparable prior year period. Despite favorable one-time pricing recoveries (net of supplier pass through requirements) in the prior year, gross profit margin improved year-over-year from 12.7% to 13.4% as a result of the strengthening of the US dollar and improved leverage of our fixed cost structure on higher sales volumes.

Material costs increased $10.0 million year-over-year on higher production levels. Labor and overhead costs increased $1.2 million year-over-year. Excluding the $6.2 million benefit from changes in foreign currency exchange rates, conversion costs increased $7.4 million due to higher sales volumes, a $2.8 million increase in Mexico labor costs and provisions for annual bonus expense of $1.3 million, offset by a $1.5 million reduction in depreciation expense.

Engineering, selling and administrative expenses were $28.9 million in the first half of fiscal 2025, compared to $26.1 million in the prior year period. Increased expenses are associated with continued investments in the business, including additional executive transition costs of $1.1 million, an annual bonus provision of $1.7 million (no provision in the prior year) and a $0.3 million restructuring charge. These cost increases were partially offset by lower third party engineering spend of $1.0 million.

Interest expense relates to outstanding borrowings under our joint venture credit facility and increased to $0.6 million in the current year period from $0.4 million in the prior year due to increased interest rates.

Investment income increased to $0.8 million in the first half of fiscal 2025 from $0.2 million in the prior year reflecting increased levels of cash and cash equivalents, which are invested in overnight money market funds.

Other expense, net was $0.4 million in the current year period compared to other income, net of $1.0 million in the prior year. The change was primarily due to changes in foreign currency exchange rates and gains or losses on peso forward contracts.

The effective income tax rate was 27.0% and 24.0% for the first half of fiscal 2025 and 2024, respectively. The effective tax rate for both periods exceeds the U.S. federal statutory rate primarily because of the foreign rate differential, state income taxes, limitations on the utilization of foreign tax credits, non-deductible items and discrete items.

Liquidity and Capital Resources

At December 29, 2024, we had $42.6 million of cash and cash equivalents, of which $2.5 million was held by our foreign subsidiaries and $40.1 million was held domestically. Excess cash is held in money market funds. The following table summarizes our cash flows provided by (used in) operating, investing and financing activities (in millions):

Cash flow from operations was $20.8 million for the first half of fiscal 2025, compared to a use of cash from operations in the prior year period. The increase in cash provided by operating activities was due to reduced purchasing levels on higher sales, collection of accounts receivable and the recovery of pre-production costs.

Net cash used in investing activities was $3.0 million during the first half of fiscal 2025 compared to $2.4 million in the prior year period. Capital expenditures to support new product programs and the upgrade and replacement of existing equipment were $3.0 million in the current year period compared to $4.4 million in the prior year period. The prior year also included $2.0 million in proceeds received from the sale of our interest in a previous joint venture.

Net cash provided by financing activities resulted from purchases of common stock under our employee stock purchase plan. During the first half of fiscal 2025, we borrowed and repaid amounts under the joint venture revolving credit agreement for short term cash requirements.

At December 29, 2024, there were no borrowings outstanding under the $40 million STRATTEC revolving credit agreement and $13.0 million outstanding under the $20 million joint venture revolving credit agreement. The Company was in compliance with all covenants under its credit facilities at December 29, 2024. We believe that the revolving credit line, combined with our existing cash on hand and anticipated operating cash flows, will be adequate to meet operating, debt service and capital expenditure funding requirements for the foreseeable future.

Primary Working Capital Management

We use primary working capital as a percentage of sales (PWC %) as a key metric of working capital management. We define this metric as the sum of net accounts receivable and net inventory less accounts payable, divided by the past three months sales annualized. The following table shows a comparison of primary working capital (dollars in millions):

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We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act, are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that the information required to be disclosed by the Company in reports that it files or submits under the Exchange Act are accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of such period, our disclosure controls and procedures were effective at reaching a level of reasonable assurance. It should be noted that in designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures. We have designed our disclosure controls and procedures to reach a level of reasonable assurance of achieving the desired control objectives.

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II

Other Information

An investment in our Common Stock involves risks. Before making an investment decision, you should carefully consider all of the information in this Quarterly Report, including the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Condensed Consolidated Financial Statements and related notes. In addition, you should carefully consider the risks and uncertainties described in the section entitled “Risk Factors” in our Annual Report. If any of the identified risks are realized, our business, financial condition and operating results could be materially and adversely affected. In that case, the trading price of our Common Stock may decline. In addition, other risks of which we are currently unaware, or which we currently do not view as material, could have a material adverse effect on our business, financial condition and operating results. As of the date of this Quarterly Report, we are providing the following update to the “Business Risks – Cross-border or Tariffs” risk factor contained in our Annual Report.

Business Risks

Cross-border Trade Issues or Tariffs – Our business is impacted by international or cross-border trade, including the import and export of products and goods into and out of the United States and trade tensions among nations. The shipping of goods across national borders is often more expensive and complicated than domestic shipping. Customs and duty procedures and reviews, including duty-free thresholds in various key markets, the application of tariffs, and security related governmental processes at international borders, may increase costs, discourage cross-border purchases, delay transit and create shipping uncertainties.

We manufacture our products in Mexico and rely on a global supply chain to deliver raw materials and components that we need to manufacture our products. Our business benefits from certain free trade agreements, such as the United States-Mexico-Canada Agreement. Political and economic tensions between governments create uncertainty with respect to tariffs, taxes and trade policies. Changes in U.S. administrative policy may strain international trade relations and lead to the imposition of tariffs by the U.S. government on imports to the U.S., the imposition of non-tariff barriers or domestic preference procurement requirements, and/or the imposition of retaliatory tariffs and other reactionary measures by foreign countries involved in our business, including but not limited to Mexico, Canada, China, and European countries. These political and economic changes in policies could have a material effect on global economic conditions and significantly decrease global trade, which could adversely impact our production costs, purchased material costs, ability to compete, customer demand and short-term vehicle production levels and relationships with suppliers and customers. Any of these consequences could reduce profitability on certain of our products and have a material adverse effect on our results of operations, financial condition and cash flows.